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Why Dividends Matter

At we encourage long-term investors to buy stocks that pay safe, rising dividends. The reasons are quite straight forward: dividends are real cash that you can spend or reinvest to buy additional shares of a stock without laying out any new money.

And dividends will increase the total return of you stock investments. Suppose a stock increases in price on average three percent per year for 40 years. Every one dollar you invest would grow to $3.26. But if the stock paid a two percent dividend and you reinvest them, your annual return would be five percent so one dollar would grow to $7.04. Thus, you could have more than doubled your nest egg by merely checking off the dividend reinvestment option when you purchased the stock.

Another good investing practice is to select stocks that pay consistently rising dividends. Even small but regular increases add up over the years. For example, Colgate-Palmolive (CL), a large consumer products company, has a multi-year record of increasing its regular quarterly dividend and this policy has increased its annual dividend on a split-adjusted basis from $0.04625 in October 1987 to $0.36 in October 2007, a 678% increase. Increasing dividends help income investors keep up with inflation.

Also, check the dividend yield of a stock before you buy it. The dividend yield is the ratio of the annual dividend amount to the current price of the stock. So if the dividend is $1 and the current price is $50, the yield is 2 percent ($1/$50). But when the stock changes price, the current dividend changes accordingly. So if the stock moves up to $55, the dividend yields drops to 1.82 percent. Or if the stock price falls to $45, the dividend yield increases to 2.22 percent.

Buying a stock when its price is down temporarily is one way to capture a higher yield. But beware of a stock with an unusually high dividend yield caused by falling prices. In some cases, a struggling company could cut the dividend.

Whether you buy stocks for safe income or to accumulate shares through dividend reinvestment, sound dividend-paying stocks are winning investments. It's easy to build a portfolio of dividend-paying stocks.

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